Wednesday, April 30, 2014

Mark Blaug in his influential book The Methodology of Economics (2nd edn.; 1992) dismissed Ludwig von Mises’ later methodological work and apriorist praxeology as “so idiosyncratic and dogmatically stated that we can only wonder that they have been taken seriously by anyone” (Blaug 1992: 81).

This statement provokes outrage from some Austrians, but Blaug was stating a simple truth.

Praxeology – Mises’ method for economic science – is based on a false and intellectually bankrupt Kantian epistemology requiring synthetic a priori knowledge.

Tuesday, April 29, 2014

The graph below shows a wholesale price index from January 1918 to June 1922 for Germany (with data from Bresciani-Turroni 1937: 442, Table V).

With regard to inflation before the catastrophic take-off of 1921, two points should be made.

First, what is noticeable here is the serious inflationary spike of late 1919 to early 1920. Presumably the depreciation of the mark in 1919 and to some extent the large deficit of 1919 were linked to this inflationary spike. But the inflation was probably also linked to the worldwide boom that occurred in 1919 and early 1920, as prices rose all over the world (Holtfrerich 1986: 207–208).

But, remarkably, as German investment was maintained in 1920 and a boom developed in Germany as many other Western economies like the US and the UK fell into recession (Holtfrerich 1986: 210), wholesale inflation stabilised and there was even some deflation.

From early 1920 until June 1921 there was a stability in German wholesale prices as can be seen clearly in the graph. And this was at a time when the money supply was rising sharply too and the deficits (although falling) were still large.

One has to ask why, if the budget deficits were the primary and major cause of the hyperinflation, the wholesale price index stabilised in 1920 and early 1921 and did not explode until after the London ultimatum of May 1921.

Monday, April 28, 2014

The issue of the role of the German government budget deficit in the hyperinflation is controversial. Above all, what was the role of the budget deficits in 1919, 1920 and 1921?

We can see the size of the deficit in the graph below (with data from Eichengreen 1995: 138, Table 5.1).

As we can see, the deficit of 1919 was large (larger than that of 1923, the worst year of the hyperinflation), but from 1920 to 1922 – apart from a small rise in 1921 – there was a clear falling trend. This was caused by the recovery of the German economy and by the tax reform of Matthias Erzberger passed in 1919. The falling deficit was actually a cause of increased confidence in the German economy at the time.

If the large deficits were the primary cause of the hyperinflation, then one must wonder why run-away inflation did occur earlier in 1919 or 1920.

For the historical reality is that, although from the end of the First World War until early 1920, there was a serious depreciation of the mark, a degree of stability and confidence returned in 1920:

“This [sc. crisis of confidence] came to a halt in the spring of 1920 as conflict between domestic political factions diminished, increasing imports improved living conditions, industrial production began to grow and, in March 1920, the Erzberger tax reforms were enacted. ‘[I]t seemed that a certain faith in the mark was again established among the German population.’ Confidence and optimistic expectations about the future value of the mark remained dominant until the London Ultimatum of May 1921. Prices remained broadly stable, despite the continued growth of the nominal quantity of money… .” (Holtfrerich 1986: 190).

Given the falling deficit, the tax reform, the prospects for budget balancing, and the hope that the final reparations burden would be more realistic than the initial proposed figure, the evidence would suggest that there really were grounds for confidence in the mark from 1920 to May 1921 (Webb 1989: 54; see also Burdekin and Langdana 1995: 93).

The return of a relative stability in the dollar–paper mark exchange rate in 1920 and early 1921 can be seen in the graph below (with data from Feldman 1993: 5, Table 1).

As we can see, by early 1921 the mark’s value had stabilised in terms of dollars. Then after the May 1921 London Ultimatum the catastrophic depreciation began, which was a fundamental driver of the hyperinflation.

It was only after May 1921 and the currency depreciation that run-away inflation occurred as well, as we can see in the German wholesale price index graph below (with data from Burdekin and Langdana 1995: 108, Table A5.1).

A further really catastrophic shift in domestic expectations about, and confidence in, the mark appears to have happened after June 1922 when the mark lost its role not only as a store of value but also as a unit of account (Holtfrerich 1986: 70), but this is perfectly consistent with the view that it was the accelerating currency depreciation beginning in late 1921 that was the fundamental driver of the hyperinflation.

Lünnemann and Mathä (2006) report the results of a survey on price setting behaviour of firms in Luxembourg (see also Lünnemann and Mathä 2007).

The survey was conducted by the Banque centrale du Luxembourg in the second half of 2004 and involved responses from 367 firms in the construction, industry, services, trade and retail trade sectors, and the replies were adjusted to be representative of the Luxembourg economy as a whole (Lünnemann and Mathä 2006: 7–8).

An interesting finding was that 76% of firms generate the largest share of their turnover with long-term customers (Lünnemann and Mathä 2006: 12).

An unusual finding was that purely state-dependent price reviews were more frequent than purely time-dependent rules (Lünnemann and Mathä 2006: 17), but despite this it was found too that the median firm in the survey changed its price twice a year and 28% of firms just once a year (Lünnemann and Mathä 2006: 21).

Firms were given 15 proposed theories to explain price stickiness, and were asked to rank the importance of these theories from “unimportant” (1) to “very important” (4).

The following results were obtained:

(1) Implicit contracts;

(2) Constant marginal cost;

(3) Explicit contracts;

(4) Procyclical elasticity of demand;

(5) Thick markets demand;

(6) Fixed costs / liquidity constraints;

(7) Price means Quality;

(8) Thick markets supply;

(9) Coordination failure;

(10) Threshold pricing;

(11) Temporary shock;

(12) Countercyclical finance;

(13) Menu costs;

(14) Non-price factors;

(15) Costly information.
(Lünnemann and Mathä 2006: 27).

The failure to include cost-based pricing is a bad failing of the survey, but the finding that increases in labour costs and other factor costs are the most important cause of price movements upwards tends to confirm that mark-up pricing must be a significant form of price setting (Lünnemann and Mathä 2006: 30). In contrast, a surge in demand was seen at the least important factor explaining price increases (Lünnemann and Mathä 2006: 30).

The effect of demand on price can be seen in this finding:

“... following a substantial increase in demand for their main product, almost every second firm does not change their price at all. The share of firms not adjusting their prices following an increase in demand is particularly sizeable in the trade sector (almost 60%).” (Lünnemann and Mathä 2006: 33).

For price decreases, the most important factors were price reductions by competitors and falling wage costs (Lünnemann and Mathä 2006: 31).

Though this survey is flawed by its failure to ask firms directly whether they use cost-based pricing, nevertheless the evidence on the importance of costs in relation to price and the weak role of demand are suggestive, and the importance of constant marginal cost to many firms are all important findings.

Friday, April 25, 2014

Joan Robinson’s review of Costantino Bresciani-Turroni’s The Economics of Inflation (The Economic Journal 48.191 [1938]: 507–513) contains Robinson’s views on the causes of the Weimar hyperinflation.

In essence, there are three major explanations of Weimar hyperinflation, as follows:

(1) the standard “quantity theory of money” explanation, which was sometimes called the “English” or “Allied” view. An influential statement of this view was Bresciani-Turroni (1937), and it assumes that money supply is exogenous;

(2) the “balance of payments theory” or what was called the “German” view. This explanation was pursued by Williams (1922), and Graham (1930) is considered by some to hold to some form of it;

Joan Robinson (1938) formulated this on the basis of the earlier “balance of payments” view.

First, it is necessary to stress what the argument is not about. The argument is not about whether money supply exploded in Weimar Germany or whether the Weimar government ran a huge budget deficit in 1923 that was funded by central bank money creation (or monetising of the deficit).

These things are true.

Nor, as far as I can see, do Post Keynesians dispute that a sustained general increase in prices or hyperinflation requires a growing money stock to sustain it.

But, while a money supply expansion is a necessary condition for this, what is being disputed is whether exogenous money creation was the primary causal factor. The alternative view is that money creation can be seen largely as endogenous and a type of intermediate, though necessary, cause driven by other factors.

The “balance of payments theory” argues that the severe depreciation of the German mark was the fundamental causal factor in the hyperinflation, and that in turn was driven by the burden of the reparations imposed on Germany.

We can see how the Post Keynesian view contradicts the “quantity theory” view by looking at how both sides understand the causality involved in the hyperinflation.

If one accepts the “quantity theory” view and assumes an exogenous money supply, then the chain of causality runs as follows:

First, Robinson noted that the facts seem to support the “balance of payments view”: the severe inflation that hit Germany in the later half of 1921 was preceded by the severe depreciation in the exchange value of the mark from May 1921 to November 1921 when the German government began paying large cash reparations payments (Robinson 1938: 507–508).

Of course, one has to demonstrate the causal mechanisms involved in this and look for further empirical evidence in support of it, and Robinson points to this:

“If the impulse comes from the side of the exchange, we should expect the fall in exchange to run ahead of the rise in prices, and the prices of traded goods to run ahead of home prices. This is precisely what occurred, the magnitude and speed of change being in this order: exchange, import prices, export prices, home prices, cost-of-living, wages. Moreover, the geographical diffusion of prices supports the argument, the movement spreading from the great ports and commercial centres to the interior of the country.” (Robinson 1938: 508).

Next, Robinson notes that the proponents of the “quantity theory” explanation of the hyperinflation like Bresciani-Turroni argued that this cannot be the case, because the tendency to balance of payments equilibrium would have prevented this, and that it was the German budget deficit financed by Reichsbank money creation that was the primary cause of the hyperinflation (Robinson 1938: 509).

But Robinson notes that the actual German government budget deficit was falling in 1921 and 1922: in 1920 the deficit was 6 billion gold marks, in 1921 it was 3.7 billion gold marks, and in 1922 2.4 billion (Robinson 1938: 509). Although Robinson concedes it had a role, nevertheless both the “quantity theory” view and the former “balance of payments theory” view had neglected an important missing link in the cause of the hyperinflation:

“The missing item is not far to seek. It is the rise in money wages. Neither exchange depreciation nor a budget deficit can account for inflation by itself. But if the rise in money wages is brought into the story, the part which each plays can be clearly seen. With the collapse of the mark in 1921, import prices rose abruptly, dragging home prices after them. The sudden rise in the cost of living led to urgent demands for higher wages. Unemployment was low …, profits were rising with prices, and the German workers were faced with starvation. Wage rises had to be granted. Rising wages, increasing both home costs and home money incomes, counteracted the effect of exchange depreciation in stimulating exports and restricting imports. Each rise in wages, therefore, precipitated a further fall in the exchange rate, and each fall in the exchange rate called forth a further rise in wages. This process became automatic when wages began to be paid on a cost-of-living basis … . Thus … [Bresciani-Turroni’s] contention that the collapse of the mark cannot have caused the inflation, because the exchange rate will always find an equilibrium level, is deprived of all force as soon as the rise of money wages is allotted its proper role. ….

To the extent that the Reichsbank met the demand for high-powered money and loans from the private sector as wages and prices soared and there were also both official and unofficial “supplementary currencies” improvised during the course of the hyperinflation to meet demand for money (Robinson 1938: 511), then the explosion in the money supply was endogenous to a great extent.

If one regards the Reichsbank’s money creation to finance the German budget deficits and especially the huge deficit of 1923 as “exogenous” money creation, then the continuance of hyperinflation was dependent on both endogenous and exogenous money creation: this is what “allowed it to continue” (Robinson 1938: 511). Robinson also conceded that the very large German budget deficit of 1923 also had a role in the hyperinflation (Robinson 1938: 510).*

But even these observations do not lessen the role of (1) the exchange rate depreciation as the fundamental and primary causal driver of the hyperinflation and (2) the significant role that endogenous money creation played in the explosion of the money supply.

Addendum
To gauge the role of the German government budget deficits in the period from 1919 to 1923, we can look at this graph below of German government spending and tax revenue (in billions of gold marks) (from Eichengreen 1995: 138, Table 5.1).

As we can see, the hyperinflation was accompanied by a disastrous collapse of tax revenues, especially in 1923 when the deficit widened considerably. Government spending actually fell in 1922 and only rose slightly in 1923. The major cause of the massive budget deficit in 1923, then, was tax revenue collapse, not massive increases in government spending.

Another point is that budget deficits in 1919 and 1920 were very large, but inflation did not spiral out of control in these years even though it did rise appreciably (as seen in the second graph below). If such large budget deficits were the primary cause of hyperinflation, then why did it not begin earlier in 1919 or 1920? Why did it spiral out of control only after the currency depreciation?

Note
* And we can note that Joan Robinson (1938: 510), far from being some unreasonable dogmatist, was perfectly prepared to concede that excessively large budget deficits in periods of very low unemployment can initiate inflations, and that it is “even possible that an increase in the quantity of money might start an inflation” (Robinson 1938: 511), though that was not the primary cause of German hyperinflation.

Further Reading
There is an excellent analysis of the hyperinflation here by Matias Vernengo:

Thursday, April 24, 2014

It is a perfect example of how Austrians are still mired in the false and misleading quantity theory of money, and all its mistaken assumptions.

He uses the following graph (which can be opened in a separate window) showing M2 money supply growth rates with the CPI inflation rates.

The key to understanding and interpreting this graph are the theories of

(1) endogenous money and (2) mark-up pricing.

Furthermore, the supply shocks and wage-price spirals of the 1970s – the historically specific factors – cannot be ignored either.

First, let us dispose of the quantity theory of money and explain endogenous money theory.

There are two main versions of quantity theory, as follows:

(1) The Equation of Exchange: MV = PT,
where M = quantity of money; V = velocity of circulation;P = general price level, andT = total number of transactions.

(2) the Cambridge Cash Balance equation: M = kdPY,
whereM = supply of money;kd = demand to hold money per unit of money income;P = general price level, andY = volume of all transactions in the value of national income.

A number of assumptions have to be made for the quantity theory to explain changes in the price level, as follows:

(1) prices are flexible and respond to demand changes in either (1) both the short and long run, or (2) at least in the long run. Related to this is a tacit assumption that the economy is near equilibrium in the sense of full use of resources and high employment, where stocks and capacity utilization are not fundamental methods that firms use to deal with changes in the demand for their products.

(2) money supply is exogenous;

(3) under the equation of exchange, for an increase in M to lead to a proportional increase in P, both V and T must be assumed to be stable.

Under the Cambridge Cash Balance equation, M and P are causally related, if kd and Y are constant (Thirlwall 1999).

(4) the direction of causation. The quantity theory assumes the direction of causation runs from money supply increase to price rises.

(5) in some extreme forms there is the assumption, following from (1), that money supply increases induce direct and proportional changes in the price level. (I will just note as an aside that Austrians already reject this, because they emphasise Cantillon effects, the idea that price level changes caused by increases in the quantity of money depend on the way new money is injected into the economy, and actually where it affects prices first.)

(3) The velocity of money and demand for money are unstable, subject to shocks and move pro-cyclically (Leo 2005; Levy-Orlik 2012: 170);

(4) the direction of causation. Under an endogenous system the direction of causation is generally from credit demand (via business loans to finance labour and other factor inputs) to money supply increases (Robinson 1970; Davidson and Weintraub 1973).

The reason is that (1) money is largely endogenous and (2) growth in the broad money supply is generally caused by credit growth. Many businesses finance their wage and other factor input bills with credit from banks, so that before real output grows money supply will grow.

Cost-push inflation happens in the same way: when (1) workers or unions demand higher wages and businesses agree to these increases and/or (2) prices of other factor inputs rise, then businesses will need to obtain higher levels of credit from banks. Hence broad money supply growth rates rise, but this rise precedes price increases because businesses will generally raise mark-up prices to maintain profit margins at a later time, given that most firms engage in time-dependent reviews and changes of their prices at regular intervals.

The process of a wage–price spiral involves actually this type of phenomenon, but in a vicious circle.

This crucial point about the direction of causation in the relationship between money supply and output/prices is discussed by Joan Robinson:

“The correlations to be explained [sc. in the relationship between money supply and real output] could be set out in quantity theory terms if the equation were read right-handed. Thus we might suggest that a marked rise in the level of activity is likely to be preceded by an increase in the supply of money (if M is widely defined) or in the velocity of circulation (if M is narrowly defined) because a rise in the wage bill and in borrowing for working capital is likely to precede an increase in the value of output appearing in the statistics. Or that a fall in activity sharp enough to cause losses deprives the banks of credit-worthy borrowers and brings a contraction in their position. But the tradition of Chicago consists in reading the equation from left to right. Then the observed relations are interpreted without any hypothesis at all except post hoc ergo propter hoc.” (Robinson 1970: 510–511).

Secondly, we need to understand mark-up pricing.

Many businesses – and probably a majority in any given developed capitalist economy – set their prices mainly as a profit mark-up on total average unit costs (that is, fixed plus variable costs).

Prices tend to change when total average unit costs change or when the firm wants to change its profit mark-up, and therefore supply costs are the important factor causing price changes (the overwhelming empirical evidence proving that mark-up pricing is prevalent throughout the developed world is here).

Although demand-side inflation is a real and important phenomenon, it is not the only major cause of inflation. In fact, often demand-side inflation is a grossly overestimated cause of inflation and the really important cause is increases in mark-up prices by cost-push inflation: for mark-up prices are, generally speaking, not responsive to changes in demand (Kaldor 1976: 217).

In the post-WWII world when unions were much stronger, collective bargaining in wages prevalent, and cost of living clauses standard in wage contracts, a sufficiently large rise in wages or spike in energy or raw materials costs could set off wage–price spirals, as businesses maintained their profit margin by simply raising their mark-up prices.

Now we have sketched the two theories we need to understand inflation, in addition to demand-led inflation, we can turn to an actual explanation of the 1970s inflation from its origin in the late 1960s until 1975.

We can break down the inflation trends as follows:

(1) Phase 1: 1967–1971
The US saw a spike in inflation from October 1967 to February 1970. Then inflation turned around and, although high, inflation rates gradually fell right down to June 1972.

This was preceded by a spike in M2 growth rates from January 1967 to January 1968.

In the United States, unemployment had fallen to 3.8% in 1966 and 3.6% in 1968, historically low levels. Low unemployment led to some bidding up of wages in this period in the non-unionised sector. Unionised workers in turn also demanded higher wages. The inflation in the US, then, was driven by unusually higher wage demands (Kaldor 1976: 224), just as it was throughout other Western countries. As Nicholas Kaldor noted, around 1968–1969, similar types of wage rises occurred in Japan, France, Belgium and the Netherlands, and from 1969–1970 in Germany, Italy, Switzerland and the UK, which Kaldor attributed largely to trade union action (Kaldor 1976: 224).

But then the US recession from December 1969 to November 1970 struck, and there was a marked decrease in inflation and M2 growth rates.

From April 1970, acceleration in M2 growth rates began again and (as we would expect) preceded the recovery in real output that ended this recession.

But M2 growth rates soared to a high level from April 1970 to July 1971, as the expansion in the business cycle occurred and higher wage demands continued.

The momentous event that would set the stage for the inflation in the next phase was the end of the Bretton Woods system on August 15, 1971, when Nixon closed the gold window.

The end of Bretton Woods was momentous: inflationary expectations and instability on financial and commodity markets resulted, as well as a rise in commodity speculation as a hedge against inflation. This contributed to the cost-push inflation that was being felt in many countries after 1971.

Nevertheless, the end of Bretton Woods in August, 1971 did not suddenly unleash run-away inflation. As we see in the chart, US inflation rates continued to fall until June 1972.

(2) Phase 2: 1971–1974
The spike in US inflation began again in June 1972 and continued until December 1974.

What caused this? Three major factors did:

(1) an explosion in commodity prices from 1972;

(2) wage–price spirals, and

(3) the first oil shock.

Let us start with factor (1).

In the late 1960s, the US began dismantling its commodity buffer stock policies that had previously ensured price stability in the golden age of capitalism.

The prelude to stagflation was marked by a significant explosion in commodity prices that occurred in the second half of 1972. Part of the problem was the failure of the harvest in the old Soviet Union in 1972–1973 and the unexpectedly large purchases on world markets by the Soviet state (Kaldor 1976: 228). This could have been averted had the United States not dismantled its commodity buffer stock policies in the 1960s. As we have seen above, the end of Bretton Woods also induced commodity speculation and rises in commodity prices and raw materials costs.

This feed into further price rises, which in turn exacerbated wage–price spirals.

The final factor that explains the surge in inflation down to December 1974 was the first oil shock from October 1973, when various Middle Eastern producers of oil instituted an embargo that lasted until March 1974 (Kaldor 1976: 226). In most countries, the double digit inflation of the 1970s was caused by the oil shocks (both the first and second).

This explains why M2 growth rates, while high, actually fell gradually from January 1973 to June 1974 as a recession struck the US from November 1973 to March 1975. This inflation was a supply-side phenomenon.

The accelerating inflation rates from 1973 to 1974 occurred when the US economy was in recession and this anomaly puzzled many economists at that time.

The new portmanteau word “stagflation” (stagnation + inflation) was increasingly used to describe the phenomenon, which meant the simultaneous occurrence of stagnation or recession (with high unemployment) and accelerating inflation.

I have not bothered to continue this analysis down to 1980, but it could be easily done.

The very same factors as described above also explain the second bout of stagflation and the major cause was the Second oil shock.

Tuesday, April 22, 2014

Daniel Kuehn links here to a group of libertarians who seem to want to reclaim the word “liberalism” from “progressive” or “left” liberals and demand that it be restricted to “classical liberalism.” Why? Because the modern sense betrays the original meaning, or so the argument goes (though whether the broad range of opinions within Classical liberalism is even representative of modern libertarianism seems highly dubious, to begin with).

This is rather like Austrians having a fit because the word “inflation” has evolved to mean “price inflation” rather than the earlier meaning of “monetary inflation” (for a debunking of that tired argument, see here).

But, taken seriously, this argument would require that libertarians must abandon the word “libertarian” for their own political movement.

Why is that?

We need only consult that wonderful resource, the Oxford English Dictionary (3rd. edn. 2010).

In its earliest sense, the word “libertarian” seemed to have neither a political nor economic sense, but meant simply “a person who supports the view that human beings have free will” – as opposed to “necessarians” who denied free will (Oxford English Dictionary [3rd. edn. 2010], s.v. “libertarian,” sense A.1).

The first cited use of the word in the Oxford English Dictionary is from 1789 (but of course that may not be the first instance of the word’s use in English).

Therefore if one wants to take seriously the pedantic modern attempts to reclaim “liberalism,” one might just as well complain that modern “libertarians” have misappropriated the word “libertarian.” Therefore let us leave the word “libertarian” to the philosophers!

Of course, this is an absurd argument.

And it is not that we can’t abuse words, or that words cannot corrupt moral discourse, but that words change and develop over time, and anyone who demands that some word in our political or economic vocabulary must be restricted to its original or archaic meaning – as if they have some moral right to ban others’ use of language – is engaged in legerdemain.

Sunday, April 20, 2014

There has been a lot of discussion of the labour theory of value in the comments section lately, a view which, I think, most Post Keynesians reject, and rightly so.

But Marx took the idea that labour is a measure of value and that labour is the cause of value from Ricardo (Robinson 1964: 36), and this idea in turn seems to stem from Adam Smith.

Adam Smith postulated that labour time was the criterion used in primitive societies to determine exchange value:

“In that early and rude state of society which precedes both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer. It is natural that what is usually the produce of two days’ or two hours’ labour, should be worth double of what is usually the produce of one day’s or one hour’s labour.

If the one species of labour should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour’s labour in the one way may frequently exchange for that of two hours’ labour in the other.

Or if the one species of labour requires an uncommon degree of dexterity and ingenuity, the esteem which men have for such talents will naturally give a value to their produce, superior to what would be due to the time employed about it. Such talents can seldom be acquired but in consequence of long application, and the superior value of their produce may frequently be no more than a reasonable compensation for the time and labour which must be spent in acquiring them. In the advanced state of society, allowances of this kind, for superior hardship and superior skill, are commonly made in the wages of labour; and something of the same kind must probably have taken place in its earliest and rudest period.

In this state of things, the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity is the only circumstance which can regulate the quantity exchange for which it ought commonly to purchase, command, or exchange for.” (Smith 1845: 20).

But is there any hard empirical evidence from anthropology and history that this is true?

For example, since hunters usually have different levels of skill and experience, and often success in hunting depends on luck, the hunting time for any particular animal caught could vary considerably. It is simply unclear to me why hunter-gatherers or hunter-horticulturists would have to determine exchange value in such a way, when labour time could vary to a significant degree on each occasion an animal is hunted, and it looks like Adam Smith is engaged in some speculation here that would need to be backed up with a great deal of evidence from anthropology to be taken seriously.

Perhaps that evidence exists, but perhaps not too, like many hoary old myths in economics. I have not yet had a chance to look at the anthropological literature, and so will leave the question open.

The firms were asked how they set the price of their main product, and the following answers were obtained:

Mark-up on unit variable costs | 63.1%

Regulated price | 13.3%

Other | 7.3%

No Answer | 16.3%.
(Fabiani et al. 2004: 16).

Mark-up pricing emerges as the overwhelmingly important type of price setting behaviour. It is also interesting here to see that regulated prices only account for only 13.3% of prices, which is far lower than the percentage for mark-up pricing.

As I have argued here, it is a mistake to think from survey data like this that firms are only using unit variable costs to calculate their mark-up price. On the contrary, when firms are pressed on this issue and we look at all the other empirical evidence, it emerges that most mark-up pricing firms are using total average unit costs (including fixed/overhead costs).

Firms were also asked to assess the importance of various theories explaining price rigidity and the theories were ranked as follows from most important to least important:

(1) Co-ordination failure

(2) Temporary shocks

(3) Explicit contracts

(4) Pricing thresholds

(5) Menu costs

(6) Bureaucratic reasons.
(Fabiani et al. 2004: 25).

These results are in line with other national surveys, but the failure to include cost-based as a theory was a major oversight.

Firms were also asked if a rise/fall in demand was an important factor in causing price changes, but some 51.1% of firms said demand changes were either unimportant (13%) or of minor importance (38.1%) in driving price changes (Fabiani et al. 2004: 26). Only 34% of firms said demand was an important factor.

Most firms reported that cost shocks were the most important factor driving price changes (Fabiani et al. 2004: 27).

Finally, price changes tend to be asymmetric: cost shocks are more likely to raise prices than reduce them (that is, firms often do not decrease prices if costs fall), and demand changes, to the extent they influence prices, tend to cause price decreases rather than price increases (that is, firms generally do not adjust prices upwards when demand increases but might reduce them if demand falls) (Fabiani et al. 2004: 34).

Friday, April 18, 2014

I thought that Kalecki did not accept the labour theory of value, but Matias Vernengo raises a question about this in a comment here, and asks for the evidence.

I have to admit to relying on memories of some reading on Kalecki quite a while ago, but some further research yields this interesting statement from the Polish Marxist economist Włodzimierz Brus, which seems to be from his personal conversations with Kalecki (who had returned to Poland in 1955):

“While recognizing the enormous significance of the Marxist approach and of many Marxian tools of economic analysis, Kalecki never felt that he had to accept every component of Marxian economics or to retain those parts of it which have become obsolete in view of new experience and of the progress of economic theory. He felt, for example, a strong distaste for the Marxian theory of value, which he considered metaphysical and (if I am not mistaken) never wanted to discuss.” (Brus 1977: 59).

Of course, Brus might be mistaken, but other writers on Kalecki do seem to agree that Kalecki pretty much avoided the subject of the labour theory of value in his writings, and his silence suggests that he did not support it (Sawyer 1985: 148; Toporowski 2004: 217; Chapple 1983: 551; King 2001: 609; Chapple 2013: 302: “He had no time for the labor theory of value”) or (at least) had no interest in defending it:

“Kalecki seems never to have declared himself in print as to where he stood in relation to the labour theory of value. He assumed that prices were fixed by firms according to their unit costs of production to which margins or mark-ups were added to secure certain levels of profit.” (Harcourt and Hamouda 2003 [1988]: 219).

Chapple, Simon. 1994. “Kalecki’s Theory of the Business Cycle and the General Theory,” in John Cunningham Wood (ed.), John Maynard Keynes: Critical Assessments. Second Series. Croom Helm, London. 538–559.

Thursday, April 17, 2014

Israel Kirzner relates an anecdote about Mises in his book Ludwig von Mises: The Man and his Economics (2001).

Kirzner once asked Mises how any individual person can know that other people really are “purposeful” in the sense of the human action axiom (Kirzner 2001: 88).

Kirzner relates that Mises’s answer surprised him greatly: Mises replied in effect that we know the existence of other human agents by observation (Kirzner 2001: 88).

Kirzner proceeds to use this answer to argue that Mises was not really the extreme apriorist that he is normally held to be (Kirzner 2001: 89).

However, Mises’s answer (if he really meant it) suggests another conclusion: Mises was just a confused and inconsistent thinker.

Elsewhere in his body of work, Mises regards the epistemological status of the human action axiom as synthetic a priori and a type of Kantian category prior to experience, as we can see here:

“… it is expedient to establish the fact that the starting point of all praxeological and economic reasoning, the category of human action, is proof against any criticisms and objections. No appeal to any historical or empirical considerations whatever can discover any fault in the proposition that men purposefully aim at certain chosen ends. No talk about irrationality, the unfathomable depths of the human soul, the spontaneity of the phenomena of life, automatisms, reflexes, and tropisms, can invalidate the statement that man makes use of his reason for the realization of wishes and desires. From the unshakable foundation of the category of human action praxeology and economics proceed step by step by means of discursive reasoning. Precisely defining assumptions and conditions, they construct a system of concepts and draw all the inferences implied by logically unassailable ratiocination. With regard to the results thus obtained only two attitudes are possible; either one can unmask logical errors in the chain of the deductions which produced these results, or one must acknowledge their correctness and validity.” (Mises 2008: 67).

“The human mind is not a tabula rasa on which the external events write their own history. It is equipped with a set of tools for grasping reality. Man acquired these tools, i.e., the logical structure of his mind, in the course of his evolution from an amoeba to his present state. But these tools are logically prior to any experience.

Man is not only an animal totally subject to the stimuli unavoidably determining the circumstances of his life. He is also an acting being. And the category of action is logically antecedent to any concrete act.

The fact that man does not have the creative power to imagine categories at variance with the fundamental logical relations and with the principles of causality and teleology enjoins upon us what may be called methodological apriorism.

Everybody in his daily behavior again and again bears witness to the immutability and universality of the categories of thought and action. He who addresses fellow men, who wants to inform and convince them, who asks questions and answers other people's questions, can proceed in this way only because he can appeal to something common to all men--namely, the logical structure of human reason. The idea that A could at the same time be non-A or that to prefer A to B could at the same time be to prefer B to A is simply inconceivable and absurd to a human mind. We are not in the position to comprehend any kind of prelogical or metalogical thinking. We cannot think of a world without causality and teleogy.” (Mises 2008: 35).

As I have argued here, this Misesian epistemology is entirely unconvincing.

One needs empirical evidence to determine what even constitutes a conscious and voluntary human act as defined in the action axiom.

In fact, the “action” as conceived by the human action axiom is to be strictly limited to:

(1) the conscious behaviour of humans;

(2) to exclude unconscious and involuntary behaviour, and

(3) (presumably) to non-mentally-ill human beings.

But Mises requires empirical evidence to demonstrate what these things even are and how to identify them.

To give an example: take sleep-walking. We observe human beings who perform complex physical tasks such as walking and (in extreme cases) driving motor vehicles while in a state of sleep. Such people cannot remember the experiences. Yet sleepwalkers’ eyes are open: presumably the visual system (retinas, optic nerve, visual cortices, etc.) is functioning and presumably the visual cortices show brain activity that is correlated with visual perception.

Are sleep-walkers engaged in action with a purpose? The Misesian might counter: no, because sleep-walkers are not conscious. But how on earth do we know that sleep-walkers are not conscious? Can we know it a priori?

We cannot do so, and need empirical evidence. For example, it could be that being in a sleepwalking state is like being in a dream state and involves some level of consciousness, but that most sleep-walkers simply forget the experience when they wake up. Would they then be engaged in action with a purpose?

However, it seems that most sleep-walking does not occur in REM sleep (when most people dream) but in the deepest, slow-wave sleep in which dreams are rare (Seager 1999: 34), so the idea that most sleepwalkers are genuinely unconscious is possible and probable. But, as noted above, it is empirical evidence and inductive argument that yields this type of a posteriori knowledge about sleep-walking, not a priori reasoning.

But it is far worse than this, for, as Kirzner noticed and Mises appears to have conceded, you need empirical evidence and inductive argument by analogy to make the case that other human minds even exist (Kirzner 2001: 88 even states that it is observation that convinces us to reject solipsism).

These insights are enough to damn the alleged synthetic a priori status of action axiom.

That Mises spent his life defending the Kantian synthetic a priori status of the action axiom but then casually and privately admitted to Kirzner that observation (a kind of empirical evidence) is needed to know that other purposeful human minds even exist only shows what a third rate philosopher and thinker Mises really was.

Sunday, April 13, 2014

The diagram is a revised version of my previous one, taking into account the criticisms and suggestions made.

However, the diagram still includes a few neoclassical schools on the right-hand side derived from Keynes for the sake of clarity, and also because I think that Abba Lerner, though he did make contributions to heterodox economics, essentially remained within the neoclassical tradition.

These results were already known in the 1930s and 1940s (Hall and Hitch 1939) and the “full cost” reality gave rise to the “marginalist controversy” in which neoclassical economists tried desperately to explain away the gap between their theory and reality (Lucas 2003: 203).

One solution was the doctrine of “implicit marginalism”: the idea that, while firms do not deliberately and consciously equate marginal revenue with marginal cost, in practice they nevertheless act as if they were doing so (Lucas 2003: 203). This was usually related to the methodological instrumentalism of Milton Friedman in his famous essay “The Methodology of Positive Economics” (Friedman 1953), in which Friedman argued that the best test of a theory is whether it predicts outcomes (Lucas 2003: 204), not tests of its assumptions.

Both “implicit marginalism” and Friedman’s instrumentalism have provided neoclassical economics with an absurd escape hatch to evade empirical reality.

Friedman, for example, claimed to use an empiricist (or positivist) method, but his belief that it is not necessary to test the fundamental assumptions of a theory and that only predictive powers of theories matter is utterly unconvincing.

In responding to charges that neoclassical theory was grossly unrealistic, Friedman dismissed such charges as follows:

… criticism of this type is largely beside the point unless supplemented by evidence that a hypothesis differing in one or another of these respects from the theory being criticized yields better predictions for as wide a range of phenomena. Yet most such criticism is not so supplemented; it is based almost entirely on supposedly directly perceived discrepancies between the ‘assumptions’ and the ‘real world.’ A particularly clear example is furnished by the recent criticisms of the maximization-of-returns hypothesis on the grounds that businessmen do not and indeed cannot behave as the theory ‘assumes’ they do. The evidence cited to support this assertion is generally taken either from the answers given by businessmen to questions about the factors affecting their decisions – a procedure for testing economic theories that is about on a par with testing theories of longevity by asking octogenarians how they account for their long life – or from descriptive studies of the decision-making activities of individual firms. Little if any evidence is ever cited on the conformity of businessmen’s actual market behavior – what they do rather than what they say they do – with the implications of the hypothesis being criticized, on the one hand, and of an alternative hypothesis, on the other.” (Friedman 1953: 31).

There you have it: a theory that claims to explain how a firm acts cannot be tested by asking business people how they act!

Now, while it is true that the evidence of econometrics cannot necessarily be used to settle debates in economics, the empirical evidence of direct surveys and case studies has a much greater value than econometric evidence in questions about the behaviour and decision making of firms.

The concocted analogy that Friedman gives to try and dismiss the value of empirical surveys here is a ridiculous one. While it may well be that asking old people how they personally account for their long life cannot test scientific theories of longevity, it does not follow that their evidence has no value in testing such theories: on the contrary, one can ask them how they lived and what lifestyles they had in terms of diet, exercise, smoking, drinking etc., which would be highly relevant to such theories.

And marginalist theories of price setting can be tested by asking business people whether their decision making and actions conform to the assumptions of the theory and the prior model of what constitutes rational or profit-maximising behaviour.

To return to Friedman’s statement above, he, not wishing to seem like a bizarre anti-empiricist extremist, quickly qualified his position in a footnote:

“I do not mean to imply that questionnaire studies of businessmen’s or others’ motives or beliefs about the forces affecting their behavior are useless for all purposes in economics. They may be extremely valuable in suggesting leads to follow in accounting for divergencies between predicted and observed results; that is, in constructing new hypotheses or revising old ones. Whatever their suggestive value in this respect, they seem to me almost entirely useless as a means of testing the validity of economic hypotheses.” (Friedman 1953: 31, n. 22).

But this qualification does very little to soften the extremism of Friedman’s position, which, if anything, reads more like the apriorist fantasies of Ludwig von Mises than any empiricist method, in its unwillingness to accept that empirical evidence can refute an economic theory.

Assumptions of economic theories (and indeed any theory) matter very much. One could, for example, concoct all sorts of theories with unrealistic and even absurd assumptions that manage to predict outcomes consistent with the observed data, but one must have a criterion for deciding which one is most likely the true and the best theory: here testing the fundamental assumptions of theories is necessary.

The empirical evidence of direct surveys and case studies on price setting shows that the marginalist theory of pricing in either (1) an explicit form or (2) the implicit form is mistaken and untenable (Lucas 2003: 207).

Wednesday, April 9, 2014

Following on from the last post, I post below a diagram of the left heterodox economics schools. This is a provisional diagram only, since the subject is a difficult one. Once again it needs to be opened in a separate window to be properly viewed.

I use the term “broad tent Post Keynesianism” for Post Keynesianism in the broadest sense, incorporating the different sub-schools, as described by Marc Lavoie in his talk below (from 50.37) and this fascinating paper here, with some minor differences: for example, I do not regard MMT as an Institutionalist tradition but within the broad Post Keynesian tradition (I discuss the history of MMT here).

On the extreme right I have included a column with some neoclassical schools for clarity (such as Neoclassical synthesis Keynesianism and Post Walrasianism).

I have also chosen to include Abba P. Lerner in that column (which some might find controversial).

Tuesday, April 8, 2014

The picture below is a simplified diagram of the modern schools of economics. One will have to open it in a new window to see it properly.

Economics is a discipline in which there are many different competing economic theories, and most of these theories are not just inconsistent on minor issues, but fundamentally contradictory in terms of their major and most fundamental theories.

It follows as a matter of straightforward logic that many competing theories that contradict one another in fundamental ways cannot all be true, and that a great deal of them – that is, theories that are mutually incompatible – are likely to be wrong.

Modern economics begins with Adam Smith and the Classical School, which had two offshoots: (1) Marxism (which in many ways is a development of the thought of David Ricardo) and (2) neoclassical economics.

Walras and Marshall stand out as the founders of two main neoclassical traditions. Austrian economics is an offshoot of the work of Carl Menger.

Both the economics of Marshall and Walras still stands at the heart of modern neoclassical economics, the most important theories of which are listed on the top line, and are as follows:

(1) New Classical economics;

(2) Monetarism;

(3) New Institutionalism, and

(4) New Keynesianism.

The alternative neoclassical tradition that stems from Alfred Marshall leads to probably the most important economist of the past 100 hundred years: John Maynard Keynes.

Keynes began his career as a Marshallian neoclassical economist but by the time of his fundamental work the General Theory of Employment, Interest and Money (1936) Keynes had essentially repudiated the neoclassical paradigm (though admittedly not completely).

The German Historical School was a major rival of both Classical and neoclassical economics, and it rise to both English and French offshoots but also fundamentally to the Old (American and European) Institutionalist tradition, which by the early 20th century had come to replace the German Historical School as the fundamental competitor to neoclassical economics.

Of course, one must realise that the Old Institutionalists did not all repudiate the neoclassical tradition, and many of them followed the Marshallian neoclassical tradition (Hodgson 2003: 463). Despite this, the Old Institutionalist school had impressive and considerable accomplishments: for example, the early work on administered prices/cost-based prices was done by Gardiner Means, an Old Institutionalist.

Old Institutionalism was a large and influential school in the United States, though not so much in Europe. However, the leading European Old Institutionalists were as follows:

(1) K. William Kapp (1910–1976);

(2) Gunnar Myrdal (1898–1987) and

(3) Karl Polanyi (1886–1964).

A further offshoot of Old Institutionalism was the primitivist/substantivist tradition in ancient economics, the leading figures of which were Karl Polanyi (1886–1964) and Moses I. Finley (1912–1986). Moses Finley wrote a highly influential book on the economies of ancient Greece and Rome called The Ancient Economy (1973; rev. edn. 1999), which rejects many aspects of modern neoclassical economics and is firmly in the Old Institutionalist tradition (although some of Finley’s more extreme views are no longer held even by modern Institutionalists).

Today modern non-neoclassical Institutionalist economics continues to be an alternative to the mainstream neoclassical tradition, but it is the Post Keynesian school that arguably has done most to advance economics in the non-neoclassical tradition of John Maynard Keynes.

Monday, April 7, 2014

Why? Let us look at a passage in The Acts of the Apostles which purports to be a history of the earliest Christian community. First, the New Testament Greek (the Koine text) and then an English translation:

“Now the group of those who believed was of one heart and soul, and no one claimed private ownership of any possessions, but everything they owned was held in common. ….

No person among them was needy, for as many as the owners of lands or houses were who sold them, they in turn brought the proceeds of what was sold and placed them at the apostles’ feet, and they distributed to each as anyone had need.

And there was the Levite Joseph, the one named Barnabas by the apostles (which means “son of encouragement”), a Cypriote by nationality, who owned a field and sold it and brought the money and laid it at the feet of the apostles.

But a certain man called Ananias, with his wife Sapphira, sold some property and withheld some of the money, with his wife aware of this. He brought a certain part of the money to the feet of the apostles and laid it there.

But Peter said to him: “Ananias, why has Satan filled your heart so that you lie to the Holy Spirit and withheld a part of the proceeds of the land? While it remained unsold, did it not remain your own? And after it was sold, were not the proceeds at your disposal? How is it that you have contrived this deed in your heart? You did not lie to us but to God!”

Now when Ananias heard these words, he fell down and died. And great fear seized all who heard of it. The young men came and wrapped up his body, then carried him out and buried him.

After an interval of about three hours his wife came in, not knowing what had happened. Peter said to her, “Tell me whether you and your husband sold the land for such and such a price.” And she said, “Yes, that was the price.” Then Peter said to her, “How is it that you have agreed together to put the Spirit of the Lord to the test? Look, the feet of those who have buried your husband are at the door, and they will carry you out.” Immediately she fell down at his feet and died. When the young men came in they found her dead, so they carried her out and buried her beside her husband. And great fear seized the whole church and all who heard of these things. (Acts 4.32–37 to 5.1–11).

Now being secular myself, I place no value in the passage as having anything to teach us about modern social or economic organisation.

But this story if taken seriously – and any conservative or fundamentalist Christian who believes in Biblical inerrancy or inspiration is forced to do so – attests to an early Christian communism and collectivism: common ownership or pooling of resources and redistribution of wealth.